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April 26, 2022

The Fed meeting is a week away, and the markets are coming unhinged.

It's not just a decline in stocks, but there are warning signals in the currency and interest rate markets — something isn't right.

As we know, the Fed is way behind in the inflation fight. The Fed Funds rate (the short term interbank lending rate, which they set) is 825 basis points below the rate of inflation.

History tells us, to stop this rate of change in prices, the Fed has to ratchet up the Fed Funds rate to exceed the rate of inflation. Not only do they have a long way to go, but they have publicly played the denial game on what it will take to bring inflation under control.

They've set expectations that it will be a shallow rate hiking cycle (ending somewhere under 3%).

That's a bad way to manage inflation expectations. And that's a big deal, for this reason: When people expect more inflation, they tend to behave in ways that promote more inflation (i.e. buying today, what they expect to be more expensive in the future).

Add to this, the Fed has told us that they will be shrinking the balance sheet, starting next week. This means they will be withdrawing liquidity from the economy ("quantitative tightening").

But as we've discussed, we have no record of this working. We don't have an historical reference point of a successful exit of QE. Not for the Fed. Not for any other central bank.

For the reference points we do have, we find that unforeseen consequences arise, and central banks are forced to respond with … a return to quantitative easing.

With all of this in mind, I posed this question last week: "Will the Fed even get the opportunity, this time, to start the process of "normalizing" the Fed balance sheet (i.e. quantitative tightening)?"

The answer is looking more and more like, "no."

As we discussed last week, the interest rate market is sending warning signals.

The 30-year mortgage rate is trading at the widest spread to the 10-year yield, since the March 2020 pandemic-induced economic shutdown. Prior to that, the last time we had seen this wide of a spread was when IndyMac failed in July of 2008 (and the subsequent global financial crisis).

Now the currency market is also sending warning signals.

With the prospect of rising rates in the U.S., global capital is moving into the dollar. But there seems to be more to it. The dollar is broadly very strong. In the past week, China has devalued its currency by 3% against the dollar. The Japanese yen has lost 12% of its value, relative to the dollar, in the past month. The Brazilian real has lost 8% in three days. Something is amiss, and it may be a dollar shortage within the global financial system.

Remember, as we discussed earlier this month, back in 2019, after spending eighteen months shrinking the balance sheet (2017-2019), the Fed quietly started reversing course (back to QE) — due to "strains in the money market." Things started breaking.

Are we, again, seeing cracks (this time, before the Fed even gets started)?

As I've said, we have a better chance of seeing more Fed (and global central bank) intervention in markets, rather than less.

And it may ultimately come in the form of resetting global debt, and a new monetary system — and maybe soon.

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Pro Perspectives 4/25/22

April 25, 2022

The election results in France on Sunday provided continuity for the globally coordinated social and environmental agenda. That was good for the stability of the European Union, and the euro. And it should have been positive for broad market stability.

But, then we had this other big issue looming as we headed into the weekend: China.

China has been devaluing the yuan (their currency) in a way that looks very similar to August of 2015. And they made the biggest adjustment (weakening the yuan) last night. And the central bank in China cut the reserve requirement ratio, to encourage lending and borrowing.

So, the developed market world (led by the Fed) is tightening money. And China is easing.

Why?

Because the Chinese government is locking down their economy again.

It started late last month, has worked its way through Shanghai, and now it looks like they will lock down Beijing.

We are seeing similar imagery to what was being circulated through global media/social media back in January and February of 2020. It was propaganda, and it worked to spread fear throughout the world. Like last time, we are seeing (again) images of authorities in hazmat suits "disinfecting" the streets, and (this time) barriers erected around residents to keep them in.

The promoted policy being enforced by the Chinese Communist Party is "zero covid."

Let's hope the political leaders in the developed world don't attempt to follow China's lead again on this one (i.e. "zero covid").

However, as we discussed last month, when the lockdowns re-started in China, the market behavior suggested that investors believe there is political appetite for more lockdowns (in the Western world).

At the depths of the decline today, the stocks that were UP were stocks that thrive in a lockdown: Zoom ended up finishing the day up 2.2%. DoorDash was up 3.4%. Roku was up 4.1%. And Docusign finished up 4.3%.

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Pro Perspectives 4/22/22

April 22, 2022

As we head into the weekend, markets are looking messy. Almost everything ended the day in the red.

Once again, the biggest winners on the year (commodities stocks, with very healthy tailwinds) represented some of the biggest losers on the day. Yesterday, it looked like profit taking. Today, clearly there was some hedging going into the weekend.

Take a look at the VIX …

The VIX tracks the implied volatility of S&P 500 index options. This reflects the level of certainty that market makers have, or don’t have, about the future.

To put it simply, if you are an options market maker, and you think the risk of a sharp market decline is rising, then you will charge more to sell downside protection (ex: puts on the S&P) to another market participant — just as an insurance company would charge a client more for a homeowner’s policy in an area more likely to see hurricanes.

This uncertainty premium translates into the violent spikes in the VIX that you can see on the chart.

Now, with that said, as you can see in the chart, these spikes are not too uncommon, especially in this post-pandemic environment. And this spike today in the VIX is relatively mild.

But what’s the story? What has people concerned?

Is it the fear of more aggressive Fed interest rate hikes coming down the pike? Very unlikely. As we’ve discussed, even if they moved to their target “neutral level” today (which is around 2.5%), they would still be wildly trailing inflation, and likely still fueling it.

Is it earnings? Q1 earnings season is underway, with 20% of S&P 500 companies already in. Earnings must be terrible, right? The answer is no. So far, 79% of companies have beat earnings estimates. And earnings growth is running two percentage points higher, at the moment, than the estimate that was set at the end of the quarter.

So, what is creating waves in markets?

Two things.

Likely, this chart …

This is a chart of the Chinese Yuan. The rising line represents a weaker yuan versus the U.S. dollar, and vice versa.

As you can see to the far right, we have a spike in the chart (about a 3% drop in the value of the yuan). First, it’s important to know that this chart (i.e. the value of the currency) is completely controlled by the Chinese government. They set the value of their currency, historically very cheap, to dominate the world’s export market.

So, what’s the threat? This price action of the past four days looks very similar to August of 2015, when China threatened a one-off devaluation of the yuan. Stocks fell 10% over a few days back in August of 2015, on the fear that a bigger devaluation was coming, and a global currency war might erupt (tit-for-tat devaluations). And this time, as with 2015, it’s coinciding with a sharp weakening of the Japanese yen (an export competitor).

So, we should all be paying close attention to this move in the yuan. It also has the potential to introduce China into the fold of global conflict.

Now, what else can be attributed to the waves in markets?

The French Presidential Election.

This is a big deal!

The runoff election is Sunday night. And we have a candidate, in Le Pen, that could throw a wrench in the globalist agenda, which includes the climate agenda.

How?

As we’ve discussed, Le Pen is nationalist candidate running on the platform of regaining French sovereignty. A Le Pen win would pose a risk of disintegration of the European Union, and of the common currency (the euro).

To put it simply, Le Pen is to France, what the Grexit vote was to Greece, what the Brexit vote was to the UK, and the Trump vote was to the U.S.

In all of these cases, we headed into the vote with polls that looked like this. All three outcomes went the other way.

France uses paper ballots, cast in person, and counted by hand at the polling station. We should know a winner by Sunday night.

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Pro Perspectives 4/21/22

April 21, 2022

Stocks were in a slide from the open of trading this morning. The decline accelerated when Jay Powell spoke at a round table interview at the IMF/World Bank meetings in Washington.

What did he say?

He said a 50 basis point rate hike was on the table for the May meeting, which is in two weeks. Is this enough to shake markets? A Fed willing to take the Fed Funds rate from 25 basis points to 75 basis points, in an economy with 8.5% inflation?

No. If anything it only highlights the tone deafness of the Fed and the policy error they continue to aggravate. And, related, nothing said today was new. We heard this from Powell back in March, and the market has exactly this scenario priced in (i.e. a 50 bps hike in May).

So, what gives for stocks today?

It looks like profit taking.

If we look at the biggest losers on the day in stocks, most of them have been the biggest winners on the year. The top twenty performing constituents in the S&P 500 year-to-date are up 50% on average. Today that group gave back almost 4% (on average). This is a group dominated by commodities related stocks (oil and gas, steel makers, agriculture).

What did the underlying commodities do on the day? Oil was UP 1.8%. Gold was relatively unchanged. Wheat and corn were each down around 2%. The Goldman Sachs Commodities Index was UP on the day.

What about copper? UP 0.7%.

Meanwhile, the copper stocks were hammered today. Freeport McMoran was down 10%. Teck Resources was down 8%. BHP was down 7%.

Again, these are some of the biggest winners in the stock market on the year (we own two of them in our Billionaire’s Portfolio). And they have been the big winners for good reason. Rising demand and scarce supply are a recipe for higher and higher copper prices, and higher and higher earnings. That continues for the foreseeable future. And the investment case for the oil stocks and ag stocks are similar.

Bottom line, these profit taking dips in commodities stocks are a buy.

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Pro Perspectives 4/20/22

April 20, 2022

As we discussed yesterday, global central bankers and finance ministers are gathering in Washington this week for Spring IMF and World Bank meetings.

A key concern is inflation. A bigger concern is inflation expectations.

What can be manipulated by central bankers to manage inflation expectations? Market interest rates (i.e. buying government bonds). We’ve seen plenty of it over the past 14 years.

Flatten the yield curve. Invert the yield curve. And suddenly, the experts are telling consumers and companies that economic recession is ahead. Just like that, expectations are managed. Behaviors can be changed.

But the Fed is supposed to be out of the QE business. They can’t step into the government bond market and manipulate yields anymore. Right?

Right. But the Bank of Japan is still at it. In fact, today they announced that they were a buyer of Japanese government bonds in UNLIMITED amounts. They have a stated goal of manipulating their bond market, to maintain the 10-year JGB yield at 25 basis points. That’s a license to do unlimited QE.

The European Central Bank is still at it. On the one hand, they have been telegraphing the end of QE. On the other hand, just earlier this month, it was reported by Bloomberg that they were meeting to formulate a plan to prevent a spike in sovereign bond yields in the weaker spots of Europe … IF Le Pen were to win the French election. That means, more QE.

Could this continued money printing in Europe and Japan translate into foreign central bank buying of U.S. government bonds, in effort to pin down U.S. market interest rates? Of course.

Remember, if there is one theme that has been consistent since the Global Financial Crisis, it’s been the omnipresent and celebrated (by policymakers) concept of “global coordination.”

With this in mind, as finance officials are meeting this week, the proxy on global economic recovery and inflation (the U.S. 10 year yield) curiously declined today. And, moreover, put in a technical reversal signal (an outside day).

With central banks constantly involved in government bond markets, especially in an economic recovery with rampant inflation, they can suppress, if not cancel, meaningful market signals that have historically come from the “free markets.” That’s very dangerous.

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Pro Perspectives 4/19/22

April 19, 2022

The Spring meetings of the IMF and World Bank governors are in Washington this week. These meetings include central bankers, minsters of finance, private sector executives and academics.

It’s a busy week for the central planners. These are the people that have determined that our global economy will be transformed, in coordination, to meet their vision of what is “sustainable” environmental, social and governance (ESG).

And now they are reporting on the problems they have created, and are meeting to collaborate on how to solve them.

On the former, the IMF released its annual world economic outlook report this morning. It includes growth downgrades. And inflation upgrades.

They see war-related supply shortages amplifying existing inflationary pressures, raising prices of food, energy and metals. They see risks of social unrest, and “serious risk of global economic fragmentation.”

This all sounds pretty bad.

But if there’s one thing we’ve learned through the Global Financial Crisis (GFC) and the Global Health Crisis (GHC), it’s that markets like global coordination. The turning point for markets and global confidence during the GFC, was the G20 meeting in April of 2009, when the G20 pledged to work together to resolve “a global crisis with a global solution.” Markets turned well before there was any visibility on a favorable outcome for the global financial system. On March 16th, 2020 the G7 leaders held a video conference to discuss a coordinated response.” Stocks bottomed five days later.

So, these dismal headlines from the IMF hit this morning at 9:00 est. At the 9:30 open, stocks went straight up (not down). With all of this said, it’s probably a good time to get global finance leaders together as we head into the French election this weekend. A Le Pen win (an anti-globalist and anti-euro candidate), would be highly destabilizing for the global transformation agenda. The first spot that would need globally coordinated central bank attention would be the European sovereign debt market (the bonds of the fiscally weaker euro zone countries would become very vulnerable).

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Pro Perspectives 4/18/22

April 18, 2022

We are a couple of weeks away from the Fed’s May meeting.

At this meeting, they have telegraphed a 50 basis point rate hike. And they have telegraphed the beginning of quantitative tightening.

As we’ve discussed the past couple of weeks: 1) a 50 basis points hike still puts them way behind the curve on the inflation fight. At 775 basis points behind, in the fight, every day that passes they are only adding fuel to the hottest inflation we’ve seen in four decades, … and 2) we don’t have an historical reference point of a successful exit of QE. For the reference points we do have, we find that unknown consequences arise in the quantitative tightening (QT) process, and central banks respond with … more quantitative easing.

The question is, will the Fed even get the opportunity, this time, to start the process of “normalizing” the Fed balance sheet (i.e. quantitative tightening)?

Remember, when they tried in 2017-2019, they broke the overnight interbank lending market. And by 2019, they were forced to restart QE.

This time around, while the Fed has yet to start QT, the interest rate market is already sending some warning signals.

Last week, the 10-year yield did a round trip between 2.84% to 2.64% in 48 hours — on no news. Meanwhile, the 30-year mortgage rate is trading at the widest spread to the 10-year yield, since the March 2020 pandemic-induced economic shutdown. Prior to that, the last time we had seen this wide of a spread was when IndyMac failed in July of 2008 (and the subsequent global financial crisis).

I’m not predicting failures of mortgage institutions, but I’m saying there is a strong likelihood of more intervention coming from the Fed (and other global central banks), rather than less.

Consider this: With the 30-year mortgage now above 5%, we may have (by month-end) one of only four months in the past 50-years, where the month-to-month change in mortgage rates was 1% or greater.

This move in mortgage rates highlights the adjustment that market rates are making, to catch up with inflation. Meanwhile the Fed-determined-interest-rate (the Fed Funds rate) is lagging well behind (and moving at a crawling pace away from zero-interest-rate-policy).

This creates a problem for banks, as they pay interest based on the Fed Funds rate. The average interest rate paid on checking accounts right now is 0.3%. Depositors will start looking for better alternatives (i.e. moving money).

That brings us back to the discussion we’ve had on yield curve control. This is a lever the Fed may pull (following the lead of Japan). They could keep market interest rates from running away.

But as we’ve discussed, market interest rates are a market mechanism. If explicitly suppressed in an already hot inflationary environment, inflation could run wild.

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Pro Perspectives 4/14/22

April 14, 2022

As we head into the long holiday weekend, we can see where the pain is for the market.

What does that mean?

We see plenty of the daily ebb and flow for markets, driven by news, distractions and sometimes outright sentiment manipulation (by the Fed, by the government, by corporate leaders, by Wall Street). With the noise of the day, markets will go up/ markets will go down.

But the overwhelming fundamental themes rise to the top when investors have to contemplate going home into a long weekend with positions they don’t have confidence in.

With do they do? If they are positioned against the broad fundamental theme, they course correct. With that, we close the week with lower stocks (led lower by high-valuation tech stocks) … higher crude oil … and higher yields.

This is course correcting for what seems like a market that has been offsides: wishing for the bounce back in big tech, believing that oil prices are only up for event reasons (Ukraine/Russia), and convinced that the Fed will be able to beat inflation with just a shallow path of interest rate hikes (stopping at under 3%).

That’s a dangerous market view. As such, we see the course correcting activity today, that demonstrates the respect for the big themes: 1) the globally coordinated disinvestment in fossil fuels, and 2) rising interest rate environment forced by inflation.

These fundamental realities for oil and interest rates are entrenched, and won’t change without the passage of time and “repricings.” So, we should expect much higher yields, much higher crude oil (still) and the continued rotation out of growth stocks and into value stocks (still).

My view: It’s early days for all three.

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Pro Perspectives 4/13/22

April 13, 2022

JP Morgan kicked off Q1 earnings season this morning.

It’s the biggest bank in the country. No entity is closer to the pulse of the consumer, business and government than JP Morgan.

So this should give us a clue on what the coming weeks of earnings reports will look like, right?

On that note, here’s what the headlines looked like coming into the market open this morning …

Slowdown. Profit drop. Bad news. Dislocations.

Sounds pretty bad.

Let’s take a look …

First, this is a bank that returned $4.7 billion to shareholders in the quarter. Things can’t be too bad.

At $30.7 billion, JP Morgan posted it’s third highest quarterly revenue on record. This revenue number was only topped by Q1 of last year and Q2 of 2020 — both of which were quarters where the government was handing out stimulus checks!

What about earnings? Well, in Q1 JPM broke a seven quarter streak of earnings beats. Worse, as Reuters says, they had a 42% profit drop. Are they getting squeezed by higher costs?

Not really. Before we get into the details, let’s take a look back at an excerpt from my note heading into Q2 2020 earnings (this is the quarter of the initial lockdown and the massive initial policy response).

From July 13, 2020 Pro Perspectives: “We should expect all of corporate America to take this opportunity, in their Q2 earnings reports, to put all of the bad news they can muster on the table.

In a widespread economic crisis, this is their chance to write down the value of anything they can justify, take loss provisions on as much as they can, and set the bar as low as they can, so that in the quarters ahead, they can outperform expectations.“

They did just that. In the case of JP Morgan, in the first two quarters of the pandemic, they diverted $16 billion from the bottom line, and directed that money into “loan loss reserves.” They spent the past six quarters (prior to this morning’s release), moving these “loan loss” reserves back to the bottom line, at their discretion.

With that, by the third quarter of 2020 (still in the thick of the global health crisis) they were blowing away earnings estimates and posting record earnings (an embarrassment of riches, thanks to the credit backstop supplied by the Fed and the revenue tailwinds supplied by fiscal stimulus).

Same playbook is happening now (the earnings management game).

This morning’s “hit to earnings” came from voluntary “credit costs.” Again, this is taking the opportunity to set the bar low, so that in the quarters ahead, they can manage earnings to outperform expectations.

For Q1, if we add back the money set aside as the provision for loan losses, JP Morgan would have beat earnings estimates this morning, and would have posted a net income of over $9 billion. That’s very close to record earnings, when adjusting all of the earnings of the past six quarters for either the credit reserve build or releases.

Bottom line: The activity at the country’s biggest bank is quite healthy.

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Pro Perspectives 4/12/22

April 12, 2022

Inflation for March came in at 8.5% (compared to March of last year).

That’s a hot number, above expectations, but not the double-digit number I was expecting. In fact, when I saw it, I thought immediately about the very strange trend in payroll data we’ve seen over the past year.

For eleven consecutive months, the labor department has undershot the final payroll number, every single month, by an average of 158k jobs. This, as the administration was pushing hard last year to justify another (massive) fiscal spend (the “Build Back Better” plan). The initially “disappointing” jobs numbers were quietly revised much higher in the months that followed, with little attention.

Is the government playing games with the headline inflation data?

If we look at the monthly inflation, it’s an eye-popper: up 1.2% from February to March (one month).

That number, annualized, is 15.3%! And that magnitude of monthly price jump has only happened four other times on record: 2005, 1980, 1974 and 1973. Each time, higher inflation has followed.

That said, the media was out in full force today running headlines suggesting that inflation has peaked.

This looks like the media carrying the water, trying to manage “inflation expectations.”

As we’ve discussed, the Fed is far more concerned about inflation expectations, than they are about inflation. If they lose control of expectations, people start pulling forward purchases, in anticipation of higher prices, creating a self-fulfilling upward spiral in prices.

As for prices, the only offset to the genie they (the government) knowingly unleashed in March of 2020 (through direct payments to businesses and consumers), is a wage reset (i.e. a broad-based shift in the wage scale, up).

That’s due to this chart …

Since the initial pandemic response, the money supply has grown at more than four-times the long-term annualized rate. The genie doesn’t go back in the bottle. With that, we’re getting a rise in prices (the CPI index) that’s running better than four-times the pre-pandemic trend rate.